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Classical Liberal EconomicsThe Makings of the Modern Global Economy
Thomas Cole, �Consummation of Empire,� The Course of Empire (1836)
The Path to ModernityThe Enlightenment began around the mid-17th Century and stretched into the late 18th century, laying the groundwork for the Modern Era.
Renaissance Era(14th to 17th
Century)
Enlightenment Era(Early 17th-late 18th
Century)
Medieval Era(5th to 14th
Century)
Modern Era(Early 17th-late 18th
Century)
Enlightened Political PhilosophyAlongside the Scientific Revolution, Enlightenment thinkers brought forth new ideas that challenged traditional institutions and thinking.
Francois-Marie Arouet, aka “Voltaire”1694-1778
Thomas Hobbes1588-1679
Charles-Louis de Secondat, Baron de Montesquieu1689-1755
Jean-Jacques Rousseau1712-1778
Adam Smith1723-1790
John Locke1632-1704
Men have rights!
Adam Smith
• Adam Smith was a Scottish economist and moral philosopher who taught at the University of Glasgow from 1751 to 1764 and collaborated with other Enlightenment thinkers, like David Hume and Voltaire.
• What Smith’s main argument in The Wealth of Nations? Smith authored The Theory of Moral Sentiments
in 1759 and An Inquiry into the Nature and Causes of the Wealth of Nations in 1776.
Adam Smith1723-1790
Influences on Smith’s Thinking…
• From 1764 to 1766, Smith toured Europe as a tutor, and was influenced by the thinking of French
philosophers (Physiocrats)
opposed to mercantilism, Smith’s work helped articulate their motto “Let do and let pass, the world goes on by itself” (Laissez faire et laissez passer, le monde va de luimême).
France
Scotland
Adam Smith, Book I, Chapter 1
• The Wealth of Nations wasSmith’s most important scholarly contribution:
• Opening quote: “The greatest improvement in the productive powers of
labour, and the greater part of the skill, dexterity, and judgement with which it is any where directed, or applied, seem to have been the effects of the division of labour.”
Small manufacturers and craftsmen were often skilled in all aspects of production.
Adam Smith, Book I, Chapter 1
• “To take an example… the trade of the pin-maker; a workman not educated to this business… could scarce, perhaps, with his utmost industry, make one pin in a day, and certainly could not make twenty…”
• What is the full description and main point of this example?
Small manufacturers and craftsmen were often skilled in all aspects of production.
The Pin Factory
Adam Smith, Book I, Chapter 1
• To what three factors does Smith attribute ”the great increase in the quantity of work” through the division of labor?
• SPECIALIZATION: The increase of dexterity in every particular workman
• EFFICIENCY: The saving of the time which is commonly lost in passing from one species of work to another
• TECHNOLOGY: The invention of a great number of machines to facilitate and abridge labor, and enable on mane to do the work of many.
The Fruits of Division of Labor
• Specialization
saves time and enhances overall gains from exchange (gains from trade)
“The woolen coat, for example, which covers the day-labourer, as coarse and rough as it may appear, is the produce of the joint labour of a great multitude of workmen… How many merchants and carriers, besides, must have been employed in transporting the materials from some of those workmen to others who often live in a very distant part of the country!”
Adam Smith, Book I, Chapter 1
• “In every improved society, the farmer is generally nothing but a farmer; the manufacturer, nothing but a manufacturer.”
• How and why, then, does Smith see agriculture and labor as different in the degree of specialization, and with what implication?
Adam Smith, Book I, Chapter 1
• Agriculture is special and the “impossibility of
making so complete and
entire a separation of all the different branches of labor employed in agriculture is perhaps the reason why of the productive powers of labor in this art does not always keep pace with their improvement in manufactures.
Adam Smith, Book I, Chapter 1
• “though the poor
country, notwithstanding the inferiority of its cultivation, can, in some measure, rival the rich in the cheapness and goodness of its corn, it can pretend to no such competition in its manufactures”.
• What does Smith mean,and why does he makethis point?
England
France
Poland
Prince, Pauper, or African King
• ”The accommodation of a European prince
does not always so much exceed that of an industrious and frugal peasant, as the
accommodation of
the latter exceeds
that of many an
African king, the absolute master of the lives and liberties of ten thousand naked savages.”
Adam Smith, Book I, Chapter 2
• Market exchange among humans is the result of self interest, not benevolence or wisdom.
• “the propensity to truck, barter, and exchange one thing for another… is common to all men, and to be found in no other race of animals.”
Adam Smith, Book I, Chapter 2
• “The difference of natural talents in different men is, in reality, much less than we are aware of… The difference between the most dissimilar of characters, between a philosopher and a
common street porter, seems to arise not so much from nature, as from habit, custom, and education.”
“Among men… the most dissimilar geniuses are of use to one another”
Adam Smith, Book I, Chapter 3
• “As it is the power of exchanging that gives occasion to the division of
labor, so the extent of this division must always be limited by the extent of that power, or, in other words, by the extent of the market.”
Adam Smith, Book I, Chapter 3
• The division of Labour is limited by the extent of the market.
• “There are some sorts of industry, even of the lowest kind, which can be carried on no where but in a great town. A porter, for example, can find employment and subsistence in no other place.”
Adam Smith, Book I, Chapter 3
• “As by means of water-
carriage a more extensive market is opened to every sort of industry than what land-carriage alone can afford it, so it is upon the seacoast, and along the banks of navigable rivers, that industry of every kind naturally begins to subdivide and improve itself…”
Specialization & Gains from Trade
David Ricardo expanded on Smith’s ideas, emphasizing that the greatest gains from trade are found when a country pursues its area of comparative advantage.
David Ricardo
Econtalk: Factors of Production
lA producer’s area of specialization depends on their natural factor endowments (e.g., land, labor, or capital).
l In addition, there may be other determinants of economic advantage (e.g., technology, education).
The Game of Wine & Cloth
What are Ricardo’s observations about the production of wine and cloth in England and Portugal?
Gains from Trade
A producer will experience the greatest gain by focusing on those factors and areas of production that yield the highest return.
Absolute AdvantageIf a producer is superior in a given area of production, domestic production is the best course of action. Below, each country has an obvious area of advantage in production.
Country United Kingdom United States
Workers available 200 200
Wheat bushels per worker 100 200
Tons of iron per worker 250 150
Total wheat production 20,000 40,000
Total iron production 50,000 30,000
Leveraging Your Best Advantage
Classic sexist example: If a lawyer can type faster than his secretary, should he do his own typing? Why or why not?
James Spader & Maggie Gyllenhaal develop a close working relationship in �The Secretary.� In the end, a lawyer can maximize the benefits to his firm if he exercises his or her most lucrative talents.
Specialization makes sense when each contributor has a unique ability, but what happens if a person has multiple areas of advantage?
Comparative AdvantageWhen a producer is superior to others in multiple areas of production, the area of comparative advantage is the one that offers the best return. Below, the U.K. is better at producing both wheat and iron, but should focus on iron for a greater return.
Country United Kingdom United States
Workers available 200 200
Wheat bushels per worker 150 100
Tons of iron per worker 250 150
Total wheat capacity 30,000 20,000
Total iron capacity 50,000 30,000
Opportunity CostThe lost potential gain from a course of action not taken is the “opportunity cost.”
Opportunity CostThe lost potential gain from a course of action not taken is the “opportunity cost.”
Policy Implications
Policy Implications
The writings of Smith, Ricardo, and other liberal economists encouraged
Great Britain to specialize
and abandon trade
protections in favor of freer trade relations boosted national wealth through increased gains from trade
(i.e., the Wealth of Nations).
Liberalizing Trade
• Corn Laws (1815-1846)
• Navigation Acts (1651-1849)
• Cobden Chevalier Treaty (1860)
The Industrial Revolution
• The 18th and 19th centuries brought technological
innovations in energy
(coal to steam), production (machinery), transportation
(railroads), and communications.
The invention (or perfection) of the steam engine by Thomas
Newcomen (1712) made it possible to harness the power of
combustion to increase productivity and speed up the transportation of goods in the
economy.
Technological Change and Industrial Restructuring
Shifting Global ProductionPercent Shares of Industrial Production, 1 CE -2017 CE
Final Observation
Liberal economic thinking asserts the seemingly paradoxical view that individuals operating freely in the pursuit of their own self
interest can achieve the greatest possible collective benefit.
The Pursuit of Self Interest as an Ideal Equilibrium
“Greed is good!” Gordon Gekko, Wall Street (1987)
Thank You
